Emerging Markets Report: Why it may be time to shine for emerging-market currencies in 2019

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Emerging-market investors had no place to hide in 2018. From trade spats, to rising U.S. interest rates and a strong U.S. dollar, the deck seemed stacked against them.

But that could change in 2019, according to emerging-market currency strategists.

“We think emerging-market assets across the board will outperform the U.S. in the first half of the New Year. At the moment, emerging market asset prices reflect under-owning,” Alessio de Longis, portfolio manager at OppenheimerFunds, told MarketWatch.

This summer, emerging markets got battered — led by Turkey and Argentina, both of which saw their currencies trapped in a downward spiral — as investors worried about rising interest rates in the U.S., a strong dollar and the effect this would have on developing nations with large dollar-denominated debt burdens.

For 2019, global growth promises to be the central theme that trade-war issues were for 2018. Central bankers and market participants have been voicing their concerns about a slowing of global economic growth for the past few months.

“With the economies of China and the U.S. set to slow in 2019, softer global demand is likely to weigh on EM growth,” wrote Capital Economics assistant economist James Swanston.

One positive outcome, however? It repriced assets sufficiently to result in many qualifying as being undervalued.

“In Latin America, even outside of Brazil, there are good valuations to be found. And the U.S. market is so close by. The geographic distance can really make a difference,” said Tim Atwill, head of investment strategy, Parametric Portfolio Associates.

Colombia’s peso

USDCOP, +0.00%

for example, was one of the few currencies that avoided a summer downturn, and could again be a favorite next year, market participants suggested.

In Brazil, political uncertainty abated to a degree, following the presidential election last fall, though investors are waiting to see if the new administration can achieve much-needed reforms.

Cyclicality also was a big driver in emerging economies, “we tend to see an 18-month pattern on average,” Atwill added.

Also helping matters, the Federal Reserve, which has been on the forefront of developed market central banks in raising interest rates, is moving ever closer to ending its rate-normalization cycle, analysts say. On Wednesday, the Fed raised U.S. interest rates for a fourth time in 2018, to a range of 2.25%-2.5%, but lowered its expectations for 2019 rate increases to two from three, which theoretically should alleviate some of the anticipated emerging-market headaches that derive from a stronger greenback.

Being undervalued, “in conjunction with abating trade tensions, monetary easing in China, which should appear in the economic data early next year, and a Federal Reserve that is eyeing the end of its rate hiking cycle, as well as a drop in oil prices would all help the EM story next year,” de Longis said.

Read: Investors hope for policy cues from China’s Xi are quickly dashed

The latter could particularly support the currencies of oil

CLF9, +3.72%

 importers like South Africa

USDZAR, -0.0869%

 or India

USDINR, -0.0141%

which dropped more than 12% and 14%, respectively against the U.S. dollar in 2018 so far, according to FactSet data.

Check out: Reserve Bank of India head steps down in potential blow to central bank independence

China’s fiscal easing, however, is only one part to the puzzle. The trade spat between Beijing and Washington remains unresolved, though the world’s two largest economies are appear to be engaged in constructive negotiations. A definitive solution to the spat would be beneficial to all parties, including the Asian developing markets that are part of the Chinese trading ecosystem, such as South Korea.

“China in an interesting spot with the continued slowdown towards 6% growth. Trade dispute may have some contribution to that, but deleveraging really has been the main driver, and that is critical for long-term economic health,” said Aaron Hurd, senior currency portfolio manager at State Street Global Investors.

“If China slows gradually because they’re cleaning up their debt then that’s a positive.”

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Anneken Tappe is a markets reporter for MarketWatch. She is based in New York.

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